China’s growth obsession fosters collateral fraud

FILE PHOTO: A woman walks out of the headquarters of the People's Bank of China (PBOC), the central bank, in Beijing November 20, 2013. REUTERS/Jason Lee

HONG KONG (Reuters Breakingviews) - China’s obsession with economic growth encourages officials and bankers to wink at lending based on non-existent collateral. The problem is vast, but the system is designed to look the other way. What it’s not designed to do is cope with the crisis that could ensue if asset prices fall.

A Reuters Special Report published on Thursday detailed how loans to companies are often backed by falsified assets - or by assets already pledged to other lenders. Officials are aware of the issue, yet they reject any suggestion that a credit crisis might be looming. The boilerplate response suggests foreign critics “don’t understand” the true condition of domestic finances. They are right. But bankers don’t either, and neither does the government.

Loan officers struggle to balance their mandate to support growth via lending against their fear of making a bad loan, adding to a pile of non-performing debt Fitch Ratings estimates could be as high as $2.1 trillion.

Their jobs are made harder by endemic accounting fraud in China’s private sector. Unable to trust the books, bankers look for collateral they can kick - aluminium bars or apartment complexes, for example. But this enables a vicious cycle in which even profitable companies in asset-light sectors must claim condos or piles of zinc to secure credit.

The same can be true of individuals. In the housing market, for example, mortgage officers and real estate agents often collude with borrowers to fudge paperwork and close deals. Prices keep rising, so what’s the problem?

Worrisomely, such loans are now getting sliced into tranches and resold to other private investors by the wealth management industry, adding more obfuscation. Every day, Chinese financial products look more like the ones that took down the American financial system in 2008.

The risk is a can that gets resolutely kicked down the road. This generation has never experienced a normal business cycle; China’s belief in its own exceptionalism - encouraged by state propaganda - fosters the fantasy that its economy need never experience a recession. If it does, the experience will be traumatic. Suspecting their loan ledgers are fantasy novels, banks will halt lending to the private sector, and economic activity will tank. At which point China won’t look exceptional at all.


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